1. Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse. A) True B) False 2. Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio? A) Your portfolio has a standard deviation of 30%, and its expected return is 15%. B) Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. C) Your portfolio has a beta equal to 1.6, and its expected return is 15%. D) Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. E) Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6. 3. If investors become less averse to risk, the slope of the Security Market Line (SML) will increase. A) True B) False 4. Which of the following statements is CORRECT? A) The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years. B) If a stock has a required rate of return rs = 12% and its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%. C) The stock valuation model, P0 = D1/(rs – g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate. D) The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate. E) The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time. 5. If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor thinks A) the stock is experiencing supernormal growth. B) the stock should be sold. C) the stock is a good buy. D) management is probably not trying to maximize the price per share. E) dividends are not likely to be declared. 6. The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value. A) True B) False 7. Classified stock differentiates various classes of common stock, and using it is one way companies can meet special needs such as when owners of a start-up firm need additional equity capital but don’t want to relinquish voting control. A) True B) False 8. An option that gives the holder the right to sell a stock at a specified price at some future time is A) a call option. B) a put option. C) an out-of-the-money option. D) a naked option. E) a covered option. 9. The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binominal model, what is the option’s value? A) $2.43 B) $2.70 C) $2.99 D) $3.29 E) $3.62 10. The exercise value is the positive difference between the current price of the stock and the strike price. The exercise value is zero if the stock’s price is below the strike price. A) True B) False

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